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Monday, 12 September 2016

Is this the right time to invest in real estate?

Residential real estate market is currently in a correction
phase, which began three years ago, and according to experts, will last for a
few more quarters.

Buying
real estate is widely considered a safe bet by Indian investors, even though
the market might show otherwise. Like every other market, real estate too has
its highs and lows. For instance, the real estate market boomed between 1988
and 1994, and most property prices went up by over 10 times during this period.
However, the bear market that followed was very challenging. By 2002, many
properties were being put on the market at half the peak price they achieved in
1994. If one considers the high rate of inflation during the 1994 to 2002
period, the actual correction during the bear market was more than 75 per cent.
A similar trend seems to be playing out now. Investors minted money in
residential real estate during the boom that occurred between 2002 and 2013,
with prices going up by 6-10 times in several pockets. However, experts caution
against expecting similar returns in the future, because the maximum
appreciation happened in some nascent markets like Gurgaon. "It was as an
aberration, reflecting the times and the fact that markets were in a very
nascent stage. It is not fair to expect that kind of appreciation in developed
markets," says Amit Oberoi, National Director, Knowledge Systems, Colliers
International (India).

All
speculative markets move in cycles, and the real estate market in no exception.
As is evident, the boom in the residential real estate market is over. It is
currently in a correction phase, which began three years ago, and according to
experts, will last for a few more quarters.

Lack of buyer interestThe market has witnessed a marked decline in the
number of people buying residential properties. One of the main reasons for
this is the fact that property prices remain high compared to the average
income of individuals. "There is end user interest, but what buyers are
waiting for is reasonable and affordable prices," says Sunil Sharma, CIO,
Sanctum Wealth Management. "As of now, end users are only looking at
projects that are priced appropriately," he adds.

Since the real estate prices vary significantly
across cities, the concept of affordability also needs to be analysed at the
city level. Affordability is also affected by interest rates and increase in
income. Fall in housing loan interest reduces the EMI and increases
affordability. Although the RBI has cut benchmark rates significantly in the
recent past, its transmission was much smaller. For example, home loan rates
came down only by 50-75 bps compared to 125 bps cut by the RBI, which did not
result in any significant pickup in demand. The rise in income over time also
failed to keep pace with the significant jump in real estate prices that
occurred between 2002 and 2013.

Rental yield, which is the amount of rent paid per
annum over the cost of buying a property, is another factor that determines the
level of demand, for both end users and investors. If the rent is higher than
the EMI to be paid for purchasing a property in a given area, people are more
likely to choose buying their own home over living in a rented property. This
means that the end user demand will go up if the rental yields are high.
Similarly, the return for investors who buy houses to rent out also go up and
this will increase the investment demand. However, rent didn't increase in
tandem with the jump in capital values either, and as a result, the rental
yield has dropped to a significant low, ranging from 2-4 per cent compared the housing
loan interest rate of around 9.5 per cent.

Inventory build-upAs a result of the dip in the demand for property,
investors and builders, who developed and hoarded residential properties
expecting prices to rise, found themselves unable to sell their inventory. The
unsold units in eight large cities in the country have already hit an all-time
peak of 1171 million sq ft, up by 22 per cent from last year. If the current
rate of sale persists, it will take more than three years to exhaust the
existing inventory. "Compared to an ideal inventory level of 8-12 months
at the national level, current inventories are close to 45-47 months,"
says Pankaj Kapoor, MD, Liases Foras Real Estate Rating & Research.
However, the inventory build-up would have been much higher if the builders had
not reduced the number of new projects.

Pricing pressuresThe cost of construction has risen steadily over
the past few years. With the introduction of Real Estate Regulator, the
compliance cost is also expected to go up. However, builders may not increase
the prices of units, because the large inventories they hold have cut down
their pricing power. "Instead of increasing prices, developers will try to
restore the sales volume first," says Samantak Das, Chief Economist and
National Director, Research, Knight Frank India.

The inventory build-up and lack of pricing power
has impacted the financial health of builders. This, in turn, has resulted in
significant delays in property delivery. Since it has reduced the number of
'ready to move in' flats going up for sale, there has been no price correction
for ready procession flats. With project completion delays becoming the norm,
consumer preference for ready-to-occupy properties has also increased.

Although builders have been able to manage some
price stability so far, they are now failing to sustain it. "The small
fall in interest rate is not helping builders because their borrowing cost is
still astonishingly high at 22-25 per cent," says Feroze Azeez, Deputy
CEO, Anand Rathi Private Wealth Management.

"High cost during muted demand is putting
pressure on developers to scale down their prices, and many builders are now
reducing their launch prices by 20-25 per cent," he said.

New investors bewareSo how should one proceed in the current market
conditions? That depends on what kind of deal you are looking for. While this
might be the perfect time for buyers to start searching for their dream home
and cash in on good deals, experts say that investors should stay away for a
few more years. "We do not think fresh investments in high value
residential real estate will generate returns like it did in the past,"
says Sunil Sharma, CIO, Sanctum Wealth Management. Azeez holds a similar
opinion. "We have held a negative view on residential real estate for the
past few years, and expect it to go through two or three more years of time
correction," he says.

According to experts, even if the prices witness
no correction and remain stagnant over the next few years, there is no reason
to invest in real estate, since there is a significant cost associated with
holding property. "If we consider the mortgage rate of 9.5 per cent as the
cost of holding, the total return is not likely to exceed that," says
Sharad Mittal, Director and Head, Real Estate Fund, Motilal Oswal Real Estate.

Drive a hard bargainSome
industry experts feel that buyers should take advantage of the current turmoil
in the residential market, instead of avoiding it. "Smart people buy when
the market is perceived to be weak. Since builders are offering great
flexibility in pricing and payment plans now, this is a good time to buy. But
buyers should bargain hard for a better price," says A.S.
Sivaramakrishnan, Head. Residential Services, CBRE South Asia. Oberoi concurs
with this view. "Instead of avoiding residential investments, one should
look to invest now, albeit with a lot of due diligence, and wherever possible,
buy at a discount," he says.

If you are aggressive investor and do decide to
enter the market now, experts recommend opting for under-construction flats
over ready procession ones, as the discounts on the former have gone up
significantly.

"The right approach in the current market
environment is to invest in under-construction projects by reputed developers,
in growing locations. These developers will deliver on the promised quality as
well as possession timelines," says Anuj Puri, Chairman and Country Head,
JLL India. At the same time, aggressive investors also should shed their normal
habit of buying real estate only in their home towns. "Investors should be
slightly adventurous now. They should study the market across several cities to
identify demand movement and hot investment corridors," says Puri.